Comments on an audit report - Accounting. Study Guide. Grade

Chapter 2: Companies

2.6 Comments on an audit report

The need for financial statements: there are several groups of people who will be interested in the financial statements of a business.

Several groups of people who will be interested Reasons why they are interested in the financial results • The owners of the business (shareholders). • owners are interested in the overall health of the

business.

• A potential owner. • may be interested in investing money in the business. • The management of the business (board of

directors). • use the report for planning purposes, to maintain certain good practices and to improve on areas of weakness. • Banks who have lent money to the business. • Banks are interested in whether there are enough

assets in the business to cover their loans. These assets can be sold to repay the loans.

• The employees of the business and trade unions. • They are interested in whether the business is profitable and in negotiating wage increases.

• SARS, because the company is a legal person

and has to pay tax. • SARS is interested in the profit or loss made and the tax that is paid on this. • the auditor who has to report to the shareholders

by giving his opinion on whether he thinks the financial statements are a fair reflection of the business during the financial year.

Function of the independent auditor

• the auditor must sign an Auditors Report which serves as an assurance to the shareholders that the financial statements are reliable.

• the auditor is not required to check every transaction or to check for fraud. Her function is to give the shareholders her opinion on whether or not the financial records are a true and fair representation of the company’s operations for that year at a specific date at the end of that financial year.

• The shareholders use the true and fair financial statements to make their decisions.

• If the auditor becomes aware of fraud, then he has a duty to report this to the shareholders.

• Auditors are bound by very high ethical standards and can face disciplinary proceedings if they are found to have been negligent in their work.

Quality of auditors

External Auditors should be registered professionals with professional bodies such as South African Institute of Chartered Accountants (SAICA) and the Independent Regulatory Board for Auditors (IRBA). Advantages of companies engaging registered Auditors:

• Auditors are guided by a professional code of ethics.

• Companies are assured of high quality work from qualified Auditors. • High professional standards are maintained since auditors are

answerable to their affiliate bodies.

• Disciplinary measures can be taken against Auditors who are negligent in performing their duties.

• Auditors may be deregistered from professional bodies if they commit any act of misconduct.

The role of the auditor is very important for the

shareholders because shareholders are not involved in the running

Mind the Gap CAPS Grade 12 Accounting chAptEr 2 compAniEs 55

Chapter

2

• Auditors can be sued for producing a misleading report. • Auditors may lose future contracts due to the production of

substandard work.

the independent auditor and the audit report

An auditor is a person who expresses an opinion on financial information and accounting controls. The independent auditor cannot be an employee of the company. She is appointed at the AGM (annual general meeting) by the shareholders, and not by the directors. She charges fees according to the number of hours she expects to spend on the audit.

The opinion of the independent auditor must be based on an assessment of whether the financial statements:

• Have been prepared in such a way as to give a fair representation of the company’s activity

• Are understandable and not confusing to the reader • Are prepared in accordance with GAAP

• Are prepared in accordance with the requirements of the Companies Act.

the role of internal auditors

The internal auditors ensure that the internal controls are tested and play an important role in looking for fraud or mistakes in the business. They need to check, for example, debtors, wages or computer entries in every aspect of the business.

The internal auditor will be an employee of the business organisation and will earn a salary from the company.

The independent auditor (external) will consider the checks carried out by an internal auditor.

Audit reports

Auditors will issue a report after they have completed their work to express an opinion on their findings. Such a report is addressed to the shareholders (owners of the company).The report could be:

• Qualified – a bad report with some irregularities, in which auditors have to state the kind of irregularity noted to the shareholders (qualify their statements).

• Unqualified – good report with minor irregularities if any. • Withheld/Disclaimer – very bad report in which auditors may

recommend further investigations on certain outstanding irregularities before issuing a report.

KING CODE: CODE OF GOOD GOVERNANCE: “STARDIF”

S t A R d i F

Social responsibilities

Transparencies Accountability Responsible

management

Discipline Independence Fairness

• Contributing to community in which the business operate • Does things in an open manner (no hidden agenda). • Able to explain your actions when called to as a business • Showing critical consideration for certain aspects for example taking care of the environment • Business must stick to its principles and ethics. • Business must operate without influence from outside • Being considerate to your stakeholders and giving them what they deserve.

The word, “STARDIF” will help you to remember what the Code of good governance stands for!

Chapter

2

ACTIVITIES boy and girl-left and right of page

Step by step comment EG - worked examples HINT!

e.g.

hint

activity

comment

exams

Worked example 6

EXAMPLE OF AN UNQUALIFIED REPORT

(GOOD REPORT):

You are provided with an extract from the report of the independent auditors: Audit opinion – To the shareholders:

We have examined the financial statements set out on pages 8 to 20. In our opinion, the financial statements fairly present, in all material respects, the financial position of the company at 30 June 2009 and the results of their operations and cash flows for the year ended, in accordance with International Financial Reporting Standards (IFRS), and in the manner required by the Companies Act in South Africa.

Barlow & Bokwe

Chartered Accountants (SA)

Registered Accountants and Auditors Cape Town 6 September 2009

The following questions are normally asked in an examination. Make sure that you study the above information before answering the questions.

PAY SPECIAL ATTENTION

ACTIVITIES boy and girl-left and right of page

Step by step comment EG - worked examples HINT!

e.g.

NB

hint

activity

comment

exams

1 State whether the shareholders would be satisfied or dissatisfied

with this audit report. Give a reason for your answer. [3]

2 Explain why the auditors found it necessary to stipulate the page

numbers (that is 8 to 20) in this report. [2]

3 Explain why the Companies Act makes it a requirement for public

companies to be audited by an independent auditor. [2]

4 Explain TWO major consequences for Barlow and Bokwe should

they be negligent in performing their duties. [4]

5 What actions would Barlow and Bokwe have to perform to verify the

Fixed/Tangible Assets figure in the Balance Sheet? Provide ThREE

points. [3]

6 Quinton Qwando, the major shareholder and managing director,

has informed the auditors that he intends to buy the unissued shares himself next year without advertising the new issue to the other shareholders or the public. What advice should the auditors

give to Quinton? Briefly explain. [4]

The auditor’s function is to give the shareholders who appointed him at the AGM his opinion.

The auditor is not required to check every transaction or to check for fraud.

An auditor only expresses an opinion whether or not the financial records are a true and fair representation of the company’s operations for that year at a specific date at the end of that financial year.

PAY SPECIAL ATTENTION

ACTIVITIES boy and girl-left and right of page

Step by step comment EG - worked examples HINT!

e.g.

NB

hint

activity

comment

exams

Mind the Gap CAPS Grade 12 Accounting chAptEr 2 compAniEs 57

Chapter

2 Memorandum

1. State whether the shareholders would be satisfied or dissatisfied

with this audit report. Give a reason for your answer. Satisfied 3

Any valid reason 33

Possible responses

• The financial statements are fairly presented - this is a positive report

• This is an unqualified report

• The auditors did not mention any irregularities

2 explain why the auditors found it necessary to stipulate the page numbers (i.e. 8 to 20) in this report.

They are only responsible for the pages that have been stipulated in the auditors' report 33

3 explain why the Companies Act makes it a requirement for public companies to be audited by an independent auditor.

The shareholders of a company need to have confidence in the

company’s ability to look after the investment 33

4 Name TWO major consequences for Barlow and Bokwe should

they be negligent in performing their duties.

Any two valid consequences 33

Possible responses • Can be sued

• Not be re-appointed as auditors

• Face disciplinary procedures by the professional body

5 What actions would Barlow and Bokwe have to perform to verify the Fixed/Tangible Assets figure in the Balance Sheet? Provide tHRee points.

Three actions333

Possible responses

• Examine the financial records of the business – external audit • Assess the internal control of the business

• Assess the accounting principles used by the business • Inspect the fixed asset register

6 Quinton Qwando, the major shareholder and managing director, has informed the auditors that he intends to buy the unissued shares himself next year without advertising the new issue to the other shareholders or the public. What advice should the auditors give to Quinton? Briefly explain.

Advice: This is unethical and the issue of new shares should be advertised to all according to the Memorandum and Articles of

Association, as this is a public company. 33

Explanation: The other shareholders will be disadvantaged, as Quinton will be increasing his shareholding percentage, which will effectively reduce the returns and dividends that the others are earning. By offering the shares on the open market the company could raise more money than if they sold at an agreed price to one

buyer.33

Any valid explanation.

External Auditors should be registered professionals with professional bodies such as South African Institute of Chartered Accountants (SAICA). This is to protect the shareholders and to ensure that continuous training takes place.

Remember that all fixed assets are recorded in an Asset register. Every fixed asset has its own entry in the asset register from the time bought, the yearly depreciation till the date of disposal.

It’s a good idea to learn and understand “STARDIF” for this type of question: • Transparency • Accountability • Responsible management • Discipline • Fairness

Chapter

2

ACTIVITIES boy and girl-left and right of page

Step by step comment EG - worked examples HINT!

e.g.

hint

activity

comment

exams

EXAMPLES OF AN UNQUALIFIED AND A

QUALIFIED AUDIT REPORT

You are provided with extracts from the independent audit reports of Kwela Ltd and Pomi Ltd.

extract from audit report of Kwela Ltd:

In our opinion, the financial statements fairly present, in all material respects, the financial position of this company at 28 February 2012 and the results of their operations and cash flows for the year ended in accordance with International Financial Reporting Standards, and in the manner required by the Companies Act of South Africa.

extract from audit report of Pomi Ltd:

In our opinion, except for the effects of the company’s overvaluation of its fixed assets, the financial statements fairly present the financial position of the company on 29 February 2012 and the results of their operations and cash flows for the year ended in accordance with International Financial Reporting Standards, and in the manner required by the Companies Act of South Africa.

ReQuiRed:

Consider the audit reports of Kwela Ltd and Pomi Ltd.

how would these audit reports influence James in deciding in which company to buy shares? Explain in respect of each company.

Memorandum

1. How would these audit reports influence James in deciding in which company to buy shares?

explanation on the audit report of Kwela Ltd 33

• James will know that he can rely on the figures in the financial statements as the company has received an unqualified audit report

• James will know that he can rely on the figures in the financial statements as there is fair presentation in all material respects

• The report is unqualified – it is a good (i.e. reliable) report.

explanation on the audit report of Pomi Ltd 333

• James will know that he cannot rely on the figures in the financial statements as the company has received an qualified audit report

• James will know that he cannot rely on the figures in the financial statements as they drew attention to shortcomings in the financial statements

• James will be unhappy because the fixed assets had been overvalued in the opinion of the auditors (which means that the true value of his possible investment is not certain as indicated by the net asset value).

Unqualified – good report in which there are minor irregularities if any.

Qualified – a bad report with some irregularities in which auditors have to state the kind of irregularity noted to the shareholders (qualify their statements).

Mind the Gap CAPS Grade 12 Accounting chAptEr 2 compAniEs 59

Chapter

2

PAY SPECIAL ATTENTION

ACTIVITIES boy and girl-left and right of page

Step by step comment EG - worked examples HINT!

e.g.

NB

hint

activity

comment

exams

EXAMPLE OF A WITHHELD /DISCLAIMER

AUDIT REPORT

MAR 2009

Refer to the newspaper article provided.

JSe suspends Woodview Ltd over no annual report By Ima Snoop, 12 Feb 2009

The trading of shares of furniture company Woodview Ltd were suspended by the JSE Securities Exchange yesterday after the company failed to publish its annual report three months after the end of their financial year-end.

The CEO of Woodview Ltd put out a statement explaining that the auditors had withheld their report and that this was causing a delay.

The company postponed its AGM. The shareholders have not been informed of the reason for the postponement.

Prior to the JSE’s action, the share price of Woodview Ltd dropped 30% to 140 cents per share.

The directors of Bhaga Toys Ltd are worried that a similar problem could occur in their company. Briefly explain why this would be a serious problem for the company. Provide two points

Memorandum

Refer to the newspaper article provided. the directors of Bhaga toys Ltd are worried that a similar problem could occur in their company. Briefly explain why this would be a serious problem for the company. Provide two points.

Any two valid explanations 333 333

• A delay would cause shareholders to become suspicious • Shareholders would not vote for these directors next year

• New shareholders will avoid the company and share prices could drop

• The directors would be guilty of a criminal offence. In terms of the Companies Act they have to produce financial statements within three months

• It will affect the ability to raise capital/loans in future as investors will be suspicious

If the auditor becomes aware of fraud, then he has a duty to report this to the shareholders. Auditors are bound by very high ethical standards and can face disciplinary proceedings if they are found to have been negligent in their work. Withheld – very bad report in which auditors may recommend further investigations on certain outstanding irregularities before issuing a report.

Chapter

3 Manufacturing

The manufacturing process is divided into 3 departments:

Administration department Factory Selling and distribution department Office duties are performed in this

department and include financing and investing activities.

Raw materials are taken through the manufacturing process in order to produce finished goods.

This department is responsible for the advertising, selling and delivery of the finished goods to customers.

Related costs

Administration department Factory Selling and distribution department Accountant’s salary

Bookkeeper’s salary Receptionist’s salary Cleaning staff wages Office stationery Office rent

Insurance on office equipment Depreciation on office equipment Office telephone

direct costs

Raw/direct materials

Factory workers’ wages/salaries (direct labour)

indirect costs/factory overheads Factory foreman’s salary (indirect labour)

Cleaning staff wages/salary (indirect labour) Indirect materials/consumable stores Factory rent Factory maintenance Factory insurance

Depreciation on factory equipment

Sales manager’s salary

Sales representative’s commission Salary of deliverymen

Bad debts Advertising Stationery costs Rent

Depreciation on delivery vehicle Cellphone costs of sales staff

In document Accounting. Study Guide. Grade (Page 70-77)